On October 21, 2010 the National Association of Insurance Commissioners (“NAIC”) adopted regulations on retroactive refunds of health care premiums for 2011, 2012 and 2013. 2The regulations put meat on the rather bare bones of the “medical loss ratio” provisions enacted by Congress last March in the Patient Protection and Affordable Care Act (“PPACA”). 3

Insurance is almost exclusively regulated at the state level. Currently, no federal agency has any significant experience in regulating the private health insurance market. In PPACA, Congress mandated that the NAIC – whose membership is the insurance regulators of the states and U.S. territories – develop premium refund regulations, subject to “certification” by the Secretary of the Department of Health and Human Services (“HHS”) by December 31, 2010. 4The NAIC has taken the general direction provided by Congress and crafted very detailed instructions for mandatory filings with state regulators. These filings must include data on health care claims, expenses and premiums and the premium refund computations using the methodology prescribed by the NAIC in the regulation.

The Medical Loss Ratio Provisions of PPACA

PPACA provides that health carriers must refund premiums if the medical loss ratio is less than 80 percent for individual and small employer group coverage or 85 percent for large employer group coverage. 5Congress defined the medical loss ratio as the sum of the costs of “reimbursement for clinical services” plus the costs of “activities that improve health care quality” divided by premiums. 6

The objective of the medical loss ratio refund is to limit the percentage of each premium dollar that goes to administrative costs and profit, without deterring carriers from devoting resources to non-clinical care activities designed to improve health care quality. For the refund mechanism to achieve its goals, the caps must be tight enough to encourage efficiency, but not so tight that too many carriers leave the market. The definition of “activities that improve health care quality” and the structure of the refund computations are key parts of this balancing act. In the new regulation, the NAIC has defined permissible quality improvement expenses and specified how medical loss ratios and refunds are to be determined.

The NAIC Definition of “Activities That Improve Health Care Quality”

PPACA Congress delegated this determination to the NAIC, which has developed very detailed definitions of quality improvement expenses, as well as the format in which insurers will report the loss and expense data to be used in medical loss ratio computations.

The inclusion of “activities that improve health care quality” in the medical loss ratio is not a health care cost control mechanism. The NAIC regulation expressly states that the quality improvement activities “should not be designed primarily to control or contain cost, although they may have cost reducing or cost neutral benefits as long as the primary focus is to improve quality.” 7

As PPACA does not define “activities that improve health care quality,” the NAIC had to determine which non-clinical care costs will fall within the medical loss ratio. The NAIC identified five categories of expenses that will qualify as “activities that improve health care quality.” Under the adopted regulation, an expense must: 1) Improve health outcomes, including increasing the likelihood of desired outcomes compared to a baseline and reducing health disparities among specified populations; 2) Prevent hospital readmissions; 3) Improve patient safety and reduce medical errors as well as, lower infection and mortality rates; 4) Increase wellness and promote health activities; or 5) Enhance the use of health care data to improve quality, transparency, and outcomes. 8

The NAIC used the “quality report” provision of PPACA to shape its definition of “activities that improve health care quality.” 9Under the quality report requirements, health carriers must provide enrollees with specified information on coverage benefits and provider compensation mechanisms designed to improve health care quality. The quality report topics reflect the current thinking of health experts on where quality improvement efforts should be focused. The NAIC derived three of the permitted expense categories – reductions in hospital admissions, improvement in patient safety and promotion of wellness programs – directly from the “quality report” provision of PPACA. The NAIC expanded and modified other elements of the “quality report” requirements to generate the “improve health outcomes” and “health information technology” categories for the medical loss ratio computations. These modifications make the NAIC definition of “activities that improve health care quality” broad enough to encompass innovative programs to address future health care quality issues.

Inevitably, there will be disputes over whether carriers have correctly classified costs. For example, the NAIC definition of “activities that improve health care quality” excludes concurrent utilization review, but includes comprehensive discharge planning that arranges and manages transactions from one setting to another. 10There is a continuum from identifying overly long hospital stays in light of the relevant diagnosis, gathering information to determine whether an alternative setting would be appropriate, consulting with the patient and providers on alternative settings, and managing the transition to the alternative setting. This list starts with concurrent review, an activity that that is treated as administrative overhead by the NAIC, and ends with patient consultation and discharge management activities that the NAIC treats as “activities that improve health care quality.” It is not clear where on this spectrum the line should be drawn between the excluded and included expenses.

Carriers will seek to include more expenses in the “quality improvement” categories; regulators are likely to push back, especially if there is public pressure for refunds. If excluded cost categories include activities (or potential initiatives) with a positive impact on quality, the result of the medical loss ratio requirements could be a reduction in quality (or a failure to achieve desired improvements in quality). For example, under the NAIC regulation, fraud reduction expenses are not “activities that improve health care quality,” although medically unnecessary invasive tests and surgeries do have adverse impacts on patients’ health by creating risks (and pain) without offsetting benefits. 11A carrier may be deterred from launching an innovation fraud reduction initiative (with potentials for health care quality improvements) if the expense of the program would push its medical loss ratio below the refund trigger level.

The Computation of Medical Loss Ratios and Refunds Under the NAIC Regulation

The NAIC regulation provides that each carrier (on an affiliate-by-affiliate basis) will compute three medical loss ratios for each state: one for all individual products, one for all small group products and one for all large group products. 12The medical loss ratios are to be computed on a calendar year basis, regardless of the actual coverage period. 13

For each calendar year, the carrier must to report its medical loss ratio calculations to the states by the following May 31. Where the ratio of the actual clinical costs and “activities that improve health care quality” to premiums is less than 80 percent for individual and small employer groups or 85 percent for large employer groups, the carrier must pay the difference as a premium refund. The first refunds are due on June 30, 2012.

Inherent Problems with Premium Refunds

Carriers write different mixes of business in different states. Within a state, different types of health coverage, with different cost structures, may be written by affiliated companies. Medical loss ratios tend to vary across states for different products written by the same carrier and between affiliated carriers under common ownership. For carriers writing large group coverage, variability across states may be exacerbated by the NAIC requirement that the data of a multistate employer be assigned entirely to the “situs of the contract” – the state where the contract states the policy was issued or delivered – rather than to the states where the health care services were provided to the employees. 14

If a carrier has a well-balanced mix of business in each broad product class in each state where it writes business, the medical loss ratio requirements will not be a destabilizing force. The carrier may or may not pay refunds, but it will not have an incentive to exit any specific market. However, if a carrier has high ratios in one state and low ratios in another state, it may find itself in a position where it is losing money in one state and paying refunds in another state. [In this situation, the carrier may stop selling unprofitable products in some states.

A carrier may also find that it is simultaneously paying refunds and losing money, in a given state or for an entire category of coverage country-wide. This scenario will occur if the medical loss ratio does not allow the carrier to cover essential and unavoidable administrative overhead costs. In these circumstances, carriers are likely to stop writing the unprofitable coverage, either in selected states or nationally.

The risk of market instability is especially great between now and 2014. In 2014 several provisions of PPACA that will reduce carriers’ administrative overhead take effect. These provisions include the elimination of medical underwriting costs (a corollary to the mandatory coverage requirement) and the creation of the Exchanges as a lower cost distribution channel. 15After 2014, carriers will find it significantly easier to meet the 80 percent medical loss ratio for individual and small group products if the underwriting and distribution expenses decrease as a result of the law changes.

Under PPACA, HHS has discretion to adjust the 80 percent ratio if “the application of such 80 percent may destabilize the individual market” in a state. 16The NAIC has already informed HHS that the medical loss ratio requirements may generate market instability in some states before 2014, and has requested that HHS allow state-specific downward adjustments to the 80 percent ratio for individual products upon request by a state insurance regulator. 17Unfortunately, PPACA does not give HHS any express authority to adjust the small group ratio if that market starts to implode. While the individual market is most vulnerable to meltdown, the same factors (medical underwriting costs and higher distribution costs make the very small group market vulnerable. Very small groups (fewer than 10 or 15 employees) have an expense profile that is closer to individual business than to the expenses associated with larger employers that still fall within the “small employer” category.

Conclusion

The medical loss ratios, which are applicable to health coverage in effect on January 1, 2011, have received relatively little public attention, especially compared to the loud debates over the coverage mandate and other PPACA provisions that do not take effect until 2014.

The low profile of the medical loss ratio provisions of PPACA is likely to change if carriers reduce writings in the individual or small group markets in 2011. Even if state insurance markets remain stable, public interest in the medical loss ratio provisions of PPACA will grow as the rebate payment deadline in June 2012 approaches. Ironically, people who get refunds because their carrier did not meet the medical loss ratio threshold may be happier with health care reform than people whose carriers paid more of each premium dollar to pay for clinical care and health care quality improvement activities.

Hilary Rowen is a partner at Sedgwick, Detert, Moran and Arnold, LLP. Her practice focuses on a wide range of insurance regulatory issues. She has 30 years experience with rate regulation issues involving both health and property/casualty coverage. She is the former Chief of the Insurance Division in the Office of the Massachusetts Attorney General and has joint degrees in law and public policy from Harvard Law School and the Kennedy School of Government.

Regulation for Uniform Definitions and Standardized Methodologies for Calculation of the Medical Loss Ratio for Plan Years 2011, 2012 and 2013 Per Section 2718(b) of the Public Health Services Act (“NAIC MLR Methodology Regulation”), 10/21/10, http://naic.org/index_health_reform_section.htm

Pub.L. 111-148, § 10101(f), adding Public Health Services Act (“PHSA”) § 2718(c). Except as directly granted under PPACA, the NAIC does not have rule making authority. In the ordinary course, the NAIC adopts “model” regulations in process that allows public comment. However, these model regulations only take effect upon promulgation by a state regulator. In contrast, the medical loss ratio regulations take effect upon adoption by the NAIC and certification by HHS. PPACA does not specify procedural requirements for the HHS certification. In section 1718(c), Congress has created a somewhat novel rulemaking process that reflects the dearth of insurance regulatory expertise in federal agencies.

The premiums in the denominator of the medical loss ratio are to be adjusted 1) for certain federal and state taxes and for state insurance regulatory fees, and 2) for three new mechanisms transferring premiums from insurers with lower risk/lower cost books of business to insurers with higher risk/higher cost books of business. Pub.L. 111-148, § 10101(f), adding PHSA § 2718(b).

Under the NAIC’s medical loss ratio report form, recoveries of fraudulent claims payments (or the cost of the carrier’s anti-fraud program, if less than the amount of the recoveries), are included in the numerator of the MLR. NAIC Supplemental Health Care Exhibit at p. 19.